Tuesday, March 18, 2008

Let's walk through one of my favorite thought experiments. I say to you, "I know a great way to make money through the wonders of free trade. Give me $10, and convince 99 of your friends to also give me $10." You do that, and I take the $1000. I then do something magical in the overseas black box, and a month later I have $1500. I come back to you and give you $700, saying, "The investment went well, but not quite as well as I had hoped, so here is what I have left after my 'management fee'. Give each person their $7, and catch you later."

Now we examine the winners and losers here. We will assume that the folks overseas got something out of the deal, better job prospects or something, because otherwise they wouldn't have made the deal with me. Back in this country, I'm $800 better off (yay for me!), and each investor is only $3 worse off (not enough to sue me, double yay!!). And as far as the national accounts are concerned, GDP has magically increased by $500. As I spend or invest that money, the people who get it are happier (granted, the people who would have received the 300 lost investor dollars are less happy).

Was this a good deal? Almost certainly, under standard economic theory, I've done something wonderful. Taking four criteria from a paper by Vanderbilt University economist Robert Driskill ("Deconstructing the argument for free trade"): 1) "the gains to the winners are larger than the losses to the losers" - it's clear my deal has done that; 2) "it increases GDP" - check; 3) "it increases total utility" - this is more difficult to determine, but, depending on my circumstances, $800 may be quite significant to me, and probably outweighs the minor inconvenience of losing $3, even multiplied by 100; 4) "it made more people better off than were made worse off" - the most problematic, but I could still make the case that where my $800 goes downstream will make at least as many people better off as were hurt by my scheme.

You may already see where I'm going here. Those four criteria are often used as justification for free trade and its happy cousin, the offshoring of jobs. I'm sure my little experiment could be analyzed further, but at first glance it seems that I have discovered a scheme that leads to contradictory results. Economists would say I've done something good, but I wager most people would find something reprehensible in my casual appropriation of other people's money.

What prompted this post was a post by Dani Rodrik on his blog. Rodrik, a Harvard professor, is hard to pigeonhole, and I wouldn't claim that what I'm writing is something he'd be fully behind. At any rate, his post leads to another from last September, one which summarizes the aforementioned Driskill paper.

The importance of the Driskill paper is not so much that he comes out for or against free trade; his argument is that the economics community has misrepresented the case for free trade (and has done so virtually unanimously). Obviously this is vital to understand, as most major newspapers and periodicals pick up the pro argument, simplify it, and present it as gospel truth. This then creeps into the "undisputed" category, and those people who argue that the issue is far more complicated than the standard Ricardo method states are treated as crackpots or Luddites. From Rodrik:

His main argument is that the standard renditions

gloss over a key issue the resolution of which is anything but obvious: What does it mean for a change in economic circumstances to be "good for the nation as a whole", even when some members of that nation are hurt by the change?

In other words, instead of sticking to what they are good at--analyzing trade-offs--economists typically engage in amateur normative political theorizing about what is good for society.

More from Driskill:

My point is not that the economics profession is not on the side of angels in the policy debate over trade liberalization--although I will argue that a more careful argument should lead to a more nuanced view--but that the argument is poorly made. This reflects negatively on the credibility of the economics profession as a whole: critical thinkers might believe all economic arguments are as poorly supported as is the one in support of free trade; others might believe economists are mere propagandists and handmaidens in service of some philosophical or political goal.

I invite the interested reader to read the Driskill paper, as it is analysis at its best. Again, don't go there expecting some anti-free trade screed, his point is not to argue that one way or the other - it's to examine the reasoning that goes into the blind "free trade is always good in every situation" approach. [I have more to say on this subject, and I'll follow up.]

1 comment:

Thanks for the link to Driskill's paper. Pretty good for a first draft :-)

This paper is much better than the one published last year by the Financial Services Forum, "Succeeding in the Global Economy: A New Policy Agenda for the American Worker." The authors of that paper seemed to have fallen into all of the traps most economists fall into as described by Driskill.

I might give the impression I’m against free trade and globalization, but really I’m not. I’m against some of the poor decision-making that seemed to be involved in giving away our country. I haven’t seen the big players in action, but I have been close to some of the smaller suppliers who, 10-20 years ago, negotiated bad contracts with foreign firms just to “do anything they could to close the deal” or just to “get their foot in the door.” The attitude was “If we don’t close the deal, then our competitors will.” Rather than walk away from bad deals, these companies opted to give away the farm in hopes that the foreign companies would return the favor by giving them better contract terms the next time around. Which, of course, never happens in the U.S., so why would it happen overseas? With the big egos involved, you lose face with the other party if you play softball, and the other party goes for the jugular. I’ve heard evidence that this has happened with the big U.S. corporations as well as with the little guys.

There’s nothing wrong with Japan, China, India, Germany etc. going for the best terms possible. There’s also nothing wrong with the U.S. trying to do the same.

There is way too much good stuff in Driskill's paper. I look forward to reading your follow-up post(s).